Mid-Year Review of my January 2006 forecasts for the US and Global Economy This Year: My Bearish Call on Track to Be Right
In January 2006, at the time when the market and official sector consensus was for another Goldilocks year of high U.S. and global growth, low inflation and rising asset prices, I made the following out-of-consensus and bearish 19 forecasts:
- The US economy will slow down in 2006, especially in H2, towards a 2-2.5% growth rate
- The U.S. and global housing bubble will burst – or better fizzle-out - in 2006.
- The global economy will also slow down in 2006 towards a 3.0% growth rate from 4.3% in 2005.
- The US current account deficit will worsen in 2006 towards a $900b deficit and global current account imbalances will become larger.
- The US fiscal deficit will worsen in 2006 adding to the US twin deficits.
- Rising protectionist pressures in the US and Europe.
- China will allow its currency to appreciate by at least 10% and the rest of Asia, including Japan, will follow.
-The dollar will also weaken relative to other floating currencies but by less than relative to China/Asia.
- The BW2 regime will start unraveling driven by less forex reserve accumulation in China/Asia and the movement of their currencies.
- US long term interest rate will head higher in 2006 driven by the BW2 unraveling and other global factors
- Oil prices will head again above $70 a barrel before falling once the US/global slowdown starts.
- The Fed Funds rate will go above 5% and the Fed will not be able to react to a US/global slowdown by easing rates.
- The ECB and BOJ will start tightening monetary policy and the global easy liquidity conditions will start to reverse.
- Equity markets will do poorly, especially in the U.S.
- Geo-strategic and geo-political risks will remain high and they will affect asset markets.
- High risk that a major US corporation will enter bankruptcy.
- Rising political tensions deriving from globalization and the pressures that it puts on workers in the US and Europe.
- Rising spreads on a variety of risky assets and increases in asset prices volatility.
- Increased probability of a systemic risk episode.
It may be a little early to declare victory but, in most dimensions, my bearish views on the US and global economy are starting to emerge as quite correct. The Three Bears scaring Goldilocks (that I have been referring to since the beginning of the year) – high oil prices, a flattening housing market, and rising inflation leading to higher policy rates than expected – are starting to kick in and leading to a sharp U.S. economic slowdown. Q2 growth may already be in the 2-2.5% range that I predicted in January and is likely to further decelerate in H2. As I predicted, oil would go above $70 a barrel because of geopolitics (Iran, Nigeria) and have a stagflationary impact.
The rapid increase in commodity prices in the last few years accelerated in the last few months, followed by a major and sudden fall last week that appears to be continuing today. This rollercoaster in commodity prices has renewed the debate (see Roach, Hamilton, CERA, Riholtz, Rassou and others) on whether the rapid rise in commodities prices represents an asset bubble – possibly ready to burst soon – or can rather be explained by economic fundamentals. There are many questions to be addressed. Can the increase in commodity prices be explained only by economic fundamentals? Is the sharp fall last week a temporary blip or the beginning of the bursting of this asset bubble? Could the fall be explained in terms of changing economic fundamentals?
Formally proving the existence of asset bubbles is never easy and some distinguished scholars – Garber, Fama – believe that asset price bubbles never occur and that any asset price change can be explained by some economic fundamentals.
Thus, the case for bubbles versus fundamentals must rely mostly on circumstantial – as opposed – to hard proof (something like the recent “duck test” of Baum). Keeping this caveat in mind, I will analyze a number of fundamental explanations of the recent increase in commodity prices and try to assess whether these fundamentals and their changes can explain the recent movements in commodity prices. The fundamentals/explanations that have been given for the recent rise in commodity prices include:
- High global growth leading to a sharp increase in world demand for commodities
- The rise of China and other emerging market economies and their demand for commodities
- Lack of supply and limited excess capacity because of low investment in commodities production
- An increase in global expected inflation
- Easy global liquidity conditions, low interest rates and low risk aversion leading to asset price increases
- Existence of speculators and new investors and asset instruments in the commodity markets.
Let us consider each of these fundamental explanations in sequence; and then discuss whether – and how much – a bubble could account for the recent rise – and fall – in commodity prices.
[The rest of this long research note is avaialable only to RGE Premium Content users]
After an already difficult week last week, today emerging markets experienced a massive bloodbath (the largest currency, equity and bond lossses in two years). And indeed last March I wrote a controversial blog (titled “Today Iceland: Tomorrow Turkey, Hungary, Australia, New Zealand, Spain, U.S.?“) putting in the same basket countries such as Iceland – that at the [...]
The is an ongoing debate on the direction that economic policies are taking in Latin America. One view, initially presented by
US Treasury Climbing on Mirrors to Avoid Uttering the M-Word..and Needing to Learn That It Takes Two to Tango..
So, thankfully, the US Treasury decided not to utter the dirty M (Manipulation) word about China’s currency policies (hear here my interview on Bloomberg Radio for a snap reaction on this report) The decision makes sense as: – China is a big power that does not let itself be bullied easily and a confrontational approach would [...]
Will China be Branded Manipulator? Will China Let the RMB Appreciate Faster and How Will Other Asian Currencies React?
The U.S. Treasury will publish on Wednesday its bi-yearly currency report where it will decide whether to brand China as a currency “manipulator”. In a new RGE note (for RGE premium users) Brad Seter and I discuss the economic and political considerations related to the U.S. decision on whether to utter the M (Manipulation) word and the broader [...]
I have recently written a presentation in powerpoint format (available to RGE registered users here) on the risks of a EMU break-up. In this note I consider some worrisome economic trends in some Eurozone economies, the increasing divergence of growth rates within EMU, the relative costs and benefits of an EMU exit, the scenarios on whether such [...]
Today Wolfgang Munchau wrote – in his FT column – that Italy risks exiting EMU if it does not undertake the economic reforms needed to restore its lost competitiveness. These arguments are not new to those – like myself and Lachman – who have expressed similar concerns in the recent past. But characteristically of the [...]
Oil prices are surging again, close to $69 dollar a barrel this morning. After reaching a peak above $70 a barrel following the “Katrita” hurricanes of the summer of 2005, oil price fell to the low 60s in the fall and winter of 2005 as the summer peak season of high oil demand passed and [...]
The recent speculative attack against the Icelandic currency and the incipient run on its banks is no news (actually a deja-vu as my co-author Brad Setser says) to students of financial crises in emerging market economies; Brad and I wrote an entire book about it. A combination of a large and growing current account deficit, driven in part [...]